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There’s been a lot of talk recently about how the debate over European economic problems is mostly playing out in the U.S. blogosphere. But if you really want to see an example of a country cut off from the econ blogosphere, go to Japan. Let’s not forget that until recently, Japan was the second largest economy in the world. In this post I’d like to claim that Westerners don’t have a clue as to what is going on in Japan. And I don’t mean “what’s going on” in the sense of why policy is conducted the way it is, we don’t even know the stylized facts about how Japan is doing. I’ll present two hypotheses:

For the optimistic scenario, let’s start with a Martin Wolf interview of Paul Krugman:

We have already gone straight into the issues. The conversation turns to the Japanese crisis of the 1990s. In retrospect, I suggest, the Japanese seem to have managed the aftermath of their crisis quite well.

He agrees. “What we thought was that Japan was a cautionary tale. It has turned into Japan as almost a role model. They never had as big a slump as we have had. They managed to have growing per capita income through most of what we call their ‘lost decade’. My running joke is that the group of us who were worried about Japan a dozen years ago ought to go to Tokyo and apologise to the emperor. We’ve done worse than they ever did. When people ask: might we become Japan? I say: I wish we could become Japan.”

This is interesting, as Japan has had the most contractionary demand-side policy of any country in modern history. Aggregate demand hasn’t just risen slowly; it’s been falling for two decades. All of their growth comes from the supply side—it’s a sort of anti-Keynesian story. Even worse for the Keynesians, they’ve had lots of spending on infrastructure, and big deficits, but it hasn’t boosted AD by a single yen.

I see two powerful data points that support Krugman; Japan has low unemployment, and their real GDP rose 15% between 1993 and 2011 (or 13% per capita.) That’s not fast GDP growth, but then other countries aren’t doing much better, and of course have much worse unemployment (Japan averages around 4% to 5%.)

But I think there’s an equally strong argument for the pessimistic case. I’ve always been a bit skeptical about the optimists, as I watch lots of Japanese films and occasionally read their novels. I definitely get a sense that the economy has done poorly since 1993. One film depicts a middle-aged man too proud to admit to his family that he’d lost his job, so he dresses in a suit and pretends to go to work each day.

Because of my blog I’ve had the opportunity to talk to two very well-educated Westerners who have spent lots of time living in Japan. The most recent conversation was with someone extremely pessimistic– he suggested that Japan is very much a nation in decline, by all sorts of social and economic metrics. When I mentioned the film, he said that sort of thing is very common, and was also skeptical of the official unemployment data. Both said that when you get outside of Tokyo you really see a nation in decline. The young people often have no real opportunity at all, and just live with their parents. Of course that’s also a recent trend in the West, my point is that it seems to have been going on much longer in Japan.

But that’s all anecdotal, is there any evidence to back it up?

I see one very powerful piece of evidence, the fall in NGDP. The Japanese NGDP has fallen 4.6% between 1993 and 2011, indeed by 6.7% in per capita terms. Just think about that, after 18 years the average person in Japan is making 6.7% less income than in 1993, even in nominal terms! Of course people will immediately point to the fact that RGDP has done much better. Yes, but recall that NGDP is much easier to measure than RGDP (which requires that one estimate a price index.) So we can’t be confident about the change in RGDP/person, but we can be pretty confident that NGDP has been falling.

And here’s why that’s so worrisome– the CPI is almost unchanged since 1993 (down a total of 0.4%, to be precise.) So the Japanese people are making considerably less money in nominal terms, and their cost of living (according to the official consumer price index computed by the Japanese government), is basically unchanged. If the CPI is even close to being correct, then living standards in Japan are falling significantly.

Because I speak English, I feel I have a pretty good understanding of how the economy is doing in Australia, Canada, and Britain. I don’t speak Japanese, and despite my interest in Japanese culture, I don’t really have any sense of how the Japanese economy is doing. I’d guess the pessimistic case is closer to the truth, but not just because of low aggregate demand, I suspect there are also structural rigidities.

I think it’s interesting that everyone talks about our global economy, and yet if I’m right, most Western economists are like me-- we don’t have a clue as to what’s really going on in the Japanese economy. My sense is that you’d have to have lived there, and traveled around a bit, to really understand. Maybe you’d have to know how to speak Japanese. For the rest of us, Japan might as well be on the dark side of the moon.

PS. Just to be clear, I realize my “pessimistic case” wasn’t exactly in opposition to Krugman’s point. If you just take the last 4 years, then yes, it’s possible to argue we are doing even worse—so far. But I expect our NGDP/person to rise faster than the CPI over the next 14 years. Some people argue Japan has been doing as well as the U.S. for several decades. That’s completely conditional on the Japanese GDP deflator being right, and their CPI being wrong. Those two indices are about 20% apart since 1993.

Disclosure: No positions

Source: Japan's Mysterious Economy